SYSTEM DESIGN
Understand Your Market
Designing Volatility Breakout Systems
by Paolo Pezzutti
Interested in improving your system's profit factor? Here are some suggestions.
The principle of range expansion/contraction was first studied and analyzed by Toby Crabel in Technical Analysis of STOCKS & COMMODITIES. According to Crabel, the market oscillates between contractions and expansions. When the market moves between areas of equilibrium (the balance of supply and demand), it does so quickly through range expansion days. This forms the premise of volatility breakout systems. Since traders focus on these short-term range expansions rather than the longer-term trend, their goal should be to exploit some continuation of the movement after the entry price to lock in profits.
CHARACTERISTICS
Systems are useful when it comes to understanding the dynamics of the marketplace and its underlying forces, such as those that maintain the up- or downtrend in an impressive trend day. The profitability of a system depends on its few big wins, although you may see many trades that result in small wins and losses.
FIGURE 1: S&P 500 FUTURES. These results display significant
patterns that can be applied to volatility breakout systems.
...Continued in the October 2002 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the October 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.